Financial companies around the world have already logged $1.1 trillion in losses and writedowns since the subprime mortgage crisis roiled markets from August 2007. Deteriorating economies around the world mean that figure is likely to keep rising.
With the likelihood that the worst news is ahead of us -- as far as the economy, corporate earnings and bankruptcies - investors are hard-pressed to take on more portfolio risk at this time.
The US economy will contract 2 percent this year while the 16-member euro zone shrinks 2.5 percent in 2009 and Japan’s economy will probably shrink at an annual 12.1 percent pace this quarter, the sharpest drop since 1974.
Right now there is no new lending, and without new lending it is going to be difficult for the economy to recover. With the banks in a state of catatonic fear now, they are just sitting on the capital.
As the new owner of $172.5 billion of preferred shares and warrants in 208 U.S. financial institutions, the US Treasury Department hasn’t succeeded in thawing frozen credit markets.
The Federal Reserve is also looking at ways to revive lending by using its balance sheet to hold loans and bonds that investors do not want. Even after a $1.34 trillion increase in assets on the Fed’s balance sheet last year, private borrowing costs remain at unusually high spreads over U.S. Treasury benchmarks.
Gauges of corporate borrowing costs, which reached record levels in the fourth quarter of 2008, remain three to five times their long-run averages. The spread on investment-grade corporate bonds is 6.03 percentage points, down from a record 6.56 percentage points on Dec. 5. That compares with an average of 1.23 percentage points in the previous decade.
Moreover, the U.S. dollar will get weaker versus emerging-market currencies. The reason why last year we saw weakness in emerging-market currencies is because of the rush into the U.S. Treasuries, into dollars. But that is not sustainable.
The Dollar Index that tracks the currency against six of the U.S.’s biggest trading partners fell 6 percent last month, the most since July 1985, after rising 18 percent from June to the end of November.
Investors see little need to hold dollar assets as the Fed floods the world with greenbacks, the U.S. budget deficit swells to more than $1 trillion and with the trade gap exceeding $57 billion. China even cut the share of dollars in its $1.9 trillion of reserves to about 45 percent last year from more than 70 percent in 2003.
Emerging-market bonds are starting to draw investors. The extra yield they demand to own the debt instead of Treasuries fell to 6.94 percentage points from 8.62 percentage points in October, according to JPMorgan’s EMBI+ Index.
If we see some signs of bottoming, then the extreme risk aversion will start to mitigate. At that point, we will be left with a huge amount of the dollars that have been printed and a huge amount of debt to be issued and bought.
Countries that prove better at withstanding the global slowdown should benefit as the flight to safety slows.
By Chodechai Suwanaporn
Source: Fiscal Policy Office / www.fpo.go.th